##### Table of Contents

---

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549



---



FORM 10-Q/A



---



(Amendment No. 1)

(Mark One)



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended September 30, 2003



Or



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------



Commission File Number 000-24289



---



CLICK2LEARN, INC.

(Exact name of registrant as specified in its charter)



---



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 91-1276003                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|110-110thAvenue NE, Bellevue,
Washington                       |  | 98004                               
|(Address of principal executive offices)                       |  | (Zip Code)                          



(425) 462-0501

(Registrants telephone number, including area code)



---



Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No ̈



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈No  x



The number of shares outstanding of the issuers Common Stock, par value $0.01, as of October 15, 2003 was 32,626,731 shares.



Explanatory Note



We are filing this Amendment No. 1 to our Quarterly Report on Form 10-Q
in response to comments received by us from the Staff of the Securities and Exchange Commission. Unless otherwise stated, all information contained in the amendment is as of November 12, 2003, the filing date of our original Quarterly Report on Form
10-Q for the fiscal quarter ended September 30, 2003. This amendment does not change previously reported financial statements.



---



---

##### Table of Contents

CLICK2LEARN, INC.

FORM 10Q

For the Quarter Ended September 30, 2003

TABLE OF CONTENTS



|                             |  |                                                                                                                           |  |   
|---------------------------- |  | ------------------------------------------------------------------------------------------------------------------------- |  | --
|PART IFINANCIAL INFORMATION |  | 3                                                                                                                        
|                             |  |                                                                                                                          
|Item 1.                      |  | Financial Statements                                                                                                      |  | 3 
|                             |  |                                                                                                                          
|                             |  | Unaudited Condensed Consolidated Balance Sheets as of September 30, 2003 and December 31, 2002                            |  | 3 
|                             |  |                                                                                                                          
|                             |  | Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2003 and 2002 |  | 4 
|                             |  |                                                                                                                          
|                             |  | Unaudited Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2003 and 2002           |  | 5 
|                             |  |                                                                                                                          
|                             |  | Notes to Unaudited Condensed Consolidated Financial Statements                                                            |  | 6 
|                             |  |                                                                                                                          
|Item 2.                      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                                     |  | 14
|                             |  |                                                                                                                          
|Item 3.                      |  | Quantitative and Qualitative Disclosures About Market Risk                                                                |  | 30
|                             |  |                                                                                                                          
|Item 4.                      |  | Controls and Procedures                                                                                                   |  | 31
|                             | 
|PART IIOTHER INFORMATION    |  | 32                                                                                                                       
|                             |  |                                                                                                                          
|Item 1.                      |  | Legal Proceedings                                                                                                         |  | 32
|                             |  |                                                                                                                          
|Item 2.                      |  | Change in Securities and Use of Proceeds                                                                                  |  | 32
|                             |  |                                                                                                                          
|Item 3.                      |  | Defaults upon Senior Securities                                                                                           |  | 32
|                             |  |                                                                                                                          
|Item 4.                      |  | Submission of Matters to a Vote of Securities Holders                                                                     |  | 32
|                             |  |                                                                                                                          
|Item 5.                      |  | Other Information                                                                                                         |  | 32
|                             |  |                                                                                                                          
|Item 6.                      |  | Exhibits and Reports on Form 8-K                                                                                          |  | 33
|                             | 
|SIGNATURES                   |  | 34                                                                                                                       



---

##### Table of Contents

PART IFINANCIAL INFORMATION



Item 1. Financial Statements



CLICK2LEARN, INC. AND SUBSIDIARIES



UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands except share data)



|                                                                                                                                             |  |                   |          |   |                  |   |          |  
|-------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | -------- | - | ---------------- | - | -------- | -
|                                                                                                                                             |  | September 30,2003 |          |   | December 31,2002 |  
|Assets                                                                                                                                       |  |                   |          |   |                  |   |          |  
|Current assets:                                                                                                                              |  |                   |          |   |                  |   |          |  
|Cash and cash equivalents                                                                                                                    |  | $                 | 14,909   |   |                  | $ | 3,586    |  
|Accounts receivable, net of allowance for returns and doubtful accounts of $454 in 2003 and $927 in 2002                                     |  |                   | 9,445    |   |                  |   | 10,785   |  
|Prepaid royalties and licenses                                                                                                               |  |                   | 43       |   |                  |   | 157      |  
|Other                                                                                                                                        |  |                   | 1,065    |   |                  |   | 1,619    |  
|                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total current assets                                                                                                                         |  |                   | 25,462   |   |                  |   | 16,147   |  
|Property and equipment, net                                                                                                                  |  |                   | 939      |   |                  |   | 1,214    |  
|Goodwill                                                                                                                                     |  |                   | 2,877    |   |                  |   | 2,877    |  
|Intangible assets, net                                                                                                                       |  |                   | 3,624    |   |                  |   | 4,636    |  
|Other                                                                                                                                        |  |                   | 573      |   |                  |   | 599      |  
|                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total assets                                                                                                                                 |  | $                 | 33,475   |   |                  | $ | 25,473   |  
|                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Liabilities and Stockholders Equity                                                                                                         |  |                   |          |   |                  |   |          |  
|Current liabilities:                                                                                                                         |  |                   |          |   |                  |   |          |  
|Accounts payable                                                                                                                             |  | $                 | 1,479    |   |                  | $ | 2,934    |  
|Accrued compensation and benefits                                                                                                            |  |                   | 2,560    |   |                  |   | 2,294    |  
|Deferred revenue                                                                                                                             |  |                   | 3,590    |   |                  |   | 4,435    |  
|Short term debt                                                                                                                              |  |                   | 3,534    |   |                  |   | 2,400    |  
|Other                                                                                                                                        |  |                   | 772      |   |                  |   | 1,184    |  
|                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total current liabilities                                                                                                                    |  |                   | 11,935   |   |                  |   | 13,247   |  
|Other noncurrent liabilities                                                                                                                 |  |                   |         |   |                  |   |         |  
|                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total liabilities                                                                                                                            |  |                   | 11,935   |   |                  |   | 13,247   |  
|                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Stockholders equity:                                                                                                                        |  |                   |          |   |                  |   |          |  
|Preferred stock, $0.01 par value; authorized 5,000,000 shares; issued and outstanding no shares in 2003 and 2002                             |  |                   |         |   |                  |   |         |  
|Common stock, $0.01 par value; authorized 100,000,000 shares, issued and outstanding 32,623,856 shares in 2003 and 24,600,114 shares in
2002 |  |                   | 326      |   |                  |   | 246      |  
|Additional paid-in capital                                                                                                                   |  |                   | 254,754  |   |                  |   | 242,570  |  
|Accumulated deficit                                                                                                                          |  |                   | (233,058 | ) |                  |   | (230,008 | )
|Accumulated other comprehensive loss                                                                                                         |  |                   | (482     | ) |                  |   | (582     | )
|                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total stockholders equity                                                                                                                   |  |                   | 21,540   |   |                  |   | 12,226   |  
|                                                                                                                                             |  |                   |          |   |                  |   |          |  
|Total liabilities and stockholders equity                                                                                                   |  | $                 | 33,475   |   |                  | $ | 25,473   |  
|                                                                                                                                             |  |                   |          |   |                  |   |          |  



See accompanying notes
to unaudited condensed Consolidated Financial Statements



3



---

##### Table of Contents

CLICK2LEARN, INC. AND SUBSIDIARIES



UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)



|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                              |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                              |  | 2003                            |        |   | 2002                           |   |        | 2003 |  |   | 2002   |  
|Revenue:                                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Platforms                                                     |  | $                               | 6,443  |   |                                | $ | 5,295  |      |  | $ | 19,866 |   |  | $ | 16,231  |  
|Tools                                                         |  |                                 | 672    |   |                                |   | 907    |      |  |   | 2,230  |   |  |   | 3,402   |  
|Content services                                              |  |                                 | 398    |   |                                |   | 737    |      |  |   | 1,547  |   |  |   | 2,218   |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Total revenue                                                 |  |                                 | 7,513  |   |                                |   | 6,939  |      |  |   | 23,643 |   |  |   | 21,851  |  
|                                                              |  |                                 |        |  
|Cost of revenue:                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Platforms                                                     |  |                                 | 1,812  |   |                                |   | 1,306  |      |  |   | 5,332  |   |  |   | 4,593   |  
|Tools                                                         |  |                                 | 140    |   |                                |   | 268    |      |  |   | 398    |   |  |   | 950     |  
|Content services                                              |  |                                 | 383    |   |                                |   | 577    |      |  |   | 1,401  |   |  |   | 1,884   |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Total cost of revenue                                         |  |                                 | 2,335  |   |                                |   | 2,151  |      |  |   | 7,131  |   |  |   | 7,427   |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Gross margin                                                  |  |                                 | 5,178  |   |                                |   | 4,788  |      |  |   | 16,512 |   |  |   | 14,424  |  
|                                                              |  |                                 |        |  
|Operating expenses:                                           |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Research and development                                      |  |                                 | 1,731  |   |                                |   | 1,924  |      |  |   | 4,658  |   |  |   | 6,376   |  
|Sales and marketing                                           |  |                                 | 3,308  |   |                                |   | 3,690  |      |  |   | 10,485 |   |  |   | 12,952  |  
|                                                              |  |                                 |        |  
|General and administrative                                    |  |                                 | 1,467  |   |                                |   | 1,182  |      |  |   | 4,217  |   |  |   | 4,221   |  
|                                                              |  |                                 |        |  
|Employee severance                                            |  |                                 |       |   |                                |   | 485    |      |  |   |       |   |  |   | 485     |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Total operating expenses                                      |  |                                 | 6,506  |   |                                |   | 7,281  |      |  |   | 19,360 |   |  |   | 24,034  |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Operating loss from continuing operations                     |  |                                 | (1,328 | ) |                                |   | (2,493 | )    |  |   | (2,848 | ) |  |   | (9,610  | )
|                                                              |  |                                 |        |  
|Other income (expense)                                        |  |                                 | (8     | ) |                                |   | 15     |      |  |   | (101   | ) |  |   | 28      |  
|Equity in losses of affiliate                                 |  |                                 | (25    | ) |                                |   | (25    | )    |  |   | (75    | ) |  |   | (175    | )
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Loss from continuing operations before income taxes           |  |                                 | (1,361 | ) |                                |   | (2,503 | )    |  |   | (3,024 | ) |  |   | (9,757  | )
|                                                              |  |                                 |        |  
|Income tax                                                    |  |                                 | (8     | ) |                                |   |       |      |  |   | (26    | ) |  |   |        |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Loss from continuing operations                               |  |                                 | (1,369 | ) |                                |   | (2,503 | )    |  |   | (3,050 | ) |  |   | (9,757  | )
|                                                              |  |                                 |        |  
|Loss from discontinued operations                             |  |                                 |       |   |                                |   | (4,949 | )    |  |   |       |   |  |   | (7,600  | )
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Net loss                                                      |  | $                               | (1,369 | ) |                                | $ | (7,452 | )    |  | $ | (3,050 | ) |  | $ | (17,357 | )
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Amounts per share, basic and diluted:                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Loss from continuing operations                               |  | $                               | (0.04  | ) |                                | $ | (0.10  | )    |  | $ | (0.11  | ) |  | $ | (0.40   | )
|Loss from discontinued operations                             |  |                                 |       |   |                                |   | (0.20  | )    |  |   |       |   |  |   | (0.31   | )
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Net loss                                                      |  | $                               | (0.04  | ) |                                | $ | (0.30  | )    |  | $ | (0.11  | ) |  | $ | (0.71   | )
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  
|Weighted average common shares outstanding, basic and diluted |  |                                 | 32,500 |   |                                |   | 24,498 |      |  |   | 27,721 |   |  |   | 24,321  |  
|                                                              |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |         |  



See accompanying notes
to unaudited condensed Consolidated Financial Statements



4



---

##### Table of Contents

CLICK2LEARN, INC. AND SUBSIDIARIES



UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)



|                                                                                           |  |                                        |         |   |      |   |        |  
|------------------------------------------------------------------------------------------ |  | -------------------------------------- | ------- | - | ---- | - | ------ | -
|                                                                                           |  | For the Nine Months EndedSeptember 30, |        
|                                                                                           |  | 2003                                   |         |   | 2002 |  
|Cash flows from operating activities:                                                      |  |                                        |         |   |      |   |        |  
|Continuing operations:                                                                     |  |                                        |         |   |      |   |        |  
|Net loss                                                                                   |  | $                                      | (3,050  | ) |      | $ | (9,757 | )
|Adjustments to reconcile net loss to net cash provided by continuing operating activities: |  |                                        |         |   |      |   |        |  
|Depreciation and amortization                                                              |  |                                        | 1,887   |   |      |   | 1,786  |  
|Write-off property and equipment                                                           |  |                                        |        |   |      |   | 270    |  
|Provision for returns and doubtful accounts                                                |  |                                        | (88     | ) |      |   | 936    |  
|Amortization of discount on debt                                                           |  |                                        | 66      |   |      |   |       |  
|Stock compensation expense                                                                 |  |                                        |        |   |      |   | 5      |  
|Equity losses of affiliate                                                                 |  |                                        | 75      |   |      |   | 175    |  
|Net change in certain operating assets and liabilities                                     |  |                                        | 370     |   |      |   | 4,411  |  
|                                                                                           |  |                                        |         |   |      |   |        |  
|Net cash used in continuing operating activities                                           |  |                                        | (740    | ) |      |   | (2,174 | )
|                                                                                           |  |                                        |         |   |      |   |        |  
|Discontinued operations:                                                                   |  |                                        |         |   |      |   |        |  
|Loss from discontinued operations                                                          |  |                                        |        |   |      |   | (7,600 | )
|Accounts receivable forfeited                                                              |  |                                        |        |   |      |   | 4,475  |  
|Gain on sale of assets                                                                     |  |                                        |        |   |      |   | (927   | )
|                                                                                           |  |                                        |         |   |      |   |        |  
|Net cash used in discontinued operating activities                                         |  |                                        |        |   |      |   | (4,052 | )
|                                                                                           |  |                                        |         |   |      |   |        |  
|Net cash used in operating activities                                                      |  |                                        | (740    | ) |      |   | (6,226 | )
|                                                                                           |  |                                        |         |   |      |   |        |  
|Cash flows from investing activities:                                                      |  |                                        |         |   |      |   |        |  
|Continuing operations:                                                                     |  |                                        |         |   |      |   |        |  
|Purchase of property and equipment                                                         |  |                                        | (602    | ) |      |   | (2,950 | )
|Other                                                                                      |  |                                        | (50     | ) |      |   | 18     |  
|                                                                                           |  |                                        |         |   |      |   |        |  
|Net cash used in continuing investing activities                                           |  |                                        | (652    | ) |      |   | (2,932 | )
|                                                                                           |  |                                        |         |   |      |   |        |  
|Discontinued operations:                                                                   |  |                                        |         |   |      |   |        |  
|Proceeds from sale of assets                                                               |  |                                        |        |   |      |   | 1,000  |  
|                                                                                           |  |                                        |         |   |      |   |        |  
|Net cash provided by discontinued activities                                               |  |                                        |        |   |      |   | 1,000  |  
|                                                                                           |  |                                        |         |   |      |   |        |  
|Net cash used in investing activities                                                      |  |                                        | (652    | ) |      |   | (1,932 | )
|                                                                                           |  |                                        |         |   |      |   |        |  
|Cash flows from financing activities:                                                      |  |                                        |         |   |      |   |        |  
|Repayments on debt                                                                         |  |                                        | (21,271 | ) |      |   | (388   | )
|Proceeds from borrowings                                                                   |  |                                        | 21,622  |   |      |   | 2,400  |  
|Proceeds from exercise of stock options                                                    |  |                                        | 73      |   |      |   | 95     |  
|Net proceeds from sale of common stock                                                     |  |                                        | 12,191  |   |      |   | 532    |  
|                                                                                           |  |                                        |         |   |      |   |        |  
|Net cash provided by financing activities                                                  |  |                                        | 12,615  |   |      |   | 2,639  |  
|                                                                                           |  |                                        |         |   |      |   |        |  
|Effect of foreign exchange rate changes on cash                                            |  |                                        | 100     |   |      |   | (26    | )
|                                                                                           |  |                                        |         |   |      |   |        |  
|Net increase (decrease) in cash and cash equivalents                                       |  |                                        | 11,323  |   |      |   | (5,545 | )
|Cash and cash equivalents at beginning of period                                           |  |                                        | 3,586   |   |      |   | 9,553  |  
|                                                                                           |  |                                        |         |   |      |   |        |  
|Cash and cash equivalents at end of period                                                 |  | $                                      | 14,909  |   |      | $ | 4,008  |  
|                                                                                           |  |                                        |         |   |      |   |        |  



See accompanying notes
to unaudited condensed Consolidated Financial Statements



5



---

##### Table of Contents

CLICK2LEARN, INC.



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



NOTE 1:  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



(a) Description of Business



Click2learn, Inc. (Click2learn) develops, markets, distributes, and supports an integrated suite of enterprise learning software products.
Click2learns markets are worldwide and include a broad range of industries.



(b) Basis of Presentation



The accompanying unaudited condensed consolidated financial statements of Click2learn, Inc., (Click2learn) include the accounts of Click2learn and its wholly-owned subsidiaries. All significant intercompany transactions have
been eliminated in consolidation.



These statements reflect all
normal recurring adjustments, which, in the opinion of management, are necessary for a fair presentation of the financial position and results of operations for the periods presented. Interim results of operations for the three and nine months ended
September 30, 2003 are not necessarily indicative of the operating results for the full fiscal year. Factors that may affect such operating results, include, but are not limited to, those discussed in Factors That May Affect Future Results
of Operations. Certain information and footnote disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America have been condensed or omitted
pursuant to the rules and regulations of the Securities and Exchange Commission.



These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and related notes included in Click2learns Annual Report on Form 10-K for the year ended
December 31, 2002.



(c) Other Current Assets



The following table sets forth the components of other current assets (in
thousands):



|                           |  |                    |       |                   |   |      
|-------------------------- |  | ------------------ | ----- | ----------------- | - | -----
|                           |  | September 30, 2003 |       | December 31, 2002
|Prepaid expense            |  | $                  | 455   |                   | $ | 430  
|Prepaid insurance          |  |                    | 351   |                   |   | 618  
|Other                      |  |                    | 259   |                   |   | 571  
|                           |  |                    |       |                   |   |      
|Total other current assets |  | $                  | 1,065 |                   | $ | 1,619
|                           |  |                    |       |                   |   |      



(d) Revenue
Recognition



Click2learn recognizes revenue pursuant to
the requirements of Statement of Position No. 97-2, Software Revenue Recognition (SOP 97-2), as amended by Statement of Position No. 98-9, Software Revenue Recognition with Respect to Certain Arrangements. Under SOP 97-2,
revenue attributable to an element in a customer arrangement is recognized when persuasive evidence of an arrangement exists and delivery has occurred, provided the fee is fixed or determinable, collectibility is probable and the arrangement does
not require significant customization of the software.



For all
sales, Click2learn uses either a binding purchase order or signed agreement, depending on the nature of the transaction, as evidence of an arrangement. Sales through its significant resellers are evidenced by a master agreement governing the
relationship.



6



---

##### Table of Contents

CLICK2LEARN, INC.



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



For software license fees in single element arrangements and multiple element arrangements that do
not include customization or consulting services, delivery typically is deemed to occur when the product is shipped to the customer.



At the time of each transaction, Click2learn assesses whether the fee associated with its revenue is fixed and determinable and whether or not collection
is probable. Click2learn assesses whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after Click2learns normal payment terms, based upon a variable
matrix such as a minimum level of distribution or subject to refund (other than refunds for warranty claims or its uncured defaults), Click2learn accounts for the fee as not being fixed and determinable. In these cases, Click2learn defers revenue
and recognizes it when it becomes due and payable.



Click2learn
assesses the probability of collection based on a number of factors, including past transaction history with the customer and the current financial condition of the customer. Click2learn does not request collateral from its customers. If Click2learn
determines at the time of the transaction that collection of a fee is not probable, it defers revenue until payment is received.



For multiple element arrangements, when company-specific objective evidence of fair value exists for all of the undelivered elements of the arrangement,
but does not exist for one or more of the delivered elements in the arrangement, Click2learn recognizes revenue under the residual method. Under the residual method, at the outset of the arrangement with a customer, Click2learn defers revenue for
the fair value of its undelivered elements such as consulting services and product support and upgrades, and recognizes the revenue for the remainder of the arrangement fee attributable to the elements initially delivered, such as software licenses,
when the criteria in SOP 97-2 have been met. Company-specific objective evidence is established for support and upgrades of standard products for which no installation or customization is required based upon the amounts Click2learn charges when
support and upgrades are sold separately. For multiple element arrangements involving installation or customization, company-specific objective evidence is established for support and maintenance arrangements if its customers have an optional annual
renewal rate specified in the arrangement and the rate is substantive. Company-specific objective evidence is established for consulting and installation services based on the hourly rates Click2learn charges for its employees when they are
performing these services provided Click2learn has the ability to accurately estimate the hours required to complete a project based upon its experience with similar projects.



Professional services revenue is recognized from fixed price contracts as services are provided or by using the
percentage-of-completion method of accounting, based on the ratio of labor costs incurred to the total estimated project cost, for individual fixed-price contracts. Provisions for any estimated losses on uncompleted contracts are made in the period
in which such losses become evident. Professional services revenue from time and materials contracts and training services is recognized as revenue as services are performed.



Click2learn recognizes revenue from non-refundable minimum royalty agreements from distributors or resellers upon delivery
of product to the distributor or reseller, provided no significant obligations remain outstanding and the conditions of SOP 97-2 have been met. If minimum royalties are exceeded, the additional royalties are recognized as revenue when earned, based
on the contractual reporting obligations.



Revenue from
subscription licenses, hosting agreements and support agreements is recognized on a straight-line basis over the life of the contract. We typically bill these contracts in advance and record the deferred amounts in deferred revenue.



7



---

##### Table of Contents

CLICK2LEARN, INC.



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Revenue by license and service for the three and nine months ended September 30, 2003 and 2002 is
as follows (in thousands):



|              |  |                                  |       |                                 |   |       |  |      |        |  |   |       
|------------- |  | -------------------------------- | ----- | ------------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|              |  | Three Months Ended September 30, |       | Nine Months Ended September 30,
|              |  | 2003                             |       | 2002                            |   | 2003  |  | 2002
|Revenue:      |  |                                  |       |                                 |   |       |  |      |        |  |   |       
|License       |  | $                                | 2,625 |                                 | $ | 2,517 |  | $    | 7,570  |  | $ | 8,399 
|Service       |  |                                  | 4,888 |                                 |   | 4,442 |  |      | 16,073 |  |   | 13,452
|              |  |                                  |       |                                 |   |       |  |      |        |  |   |       
|Total revenue |  | $                                | 7,513 |                                 | $ | 6,939 |  | $    | 23,643 |  | $ | 21,851
|              |  |                                  |       |                                 |   |       |  |      |        |  |   |       



(e) Net Loss
Per Share



Basic net loss per share is computed by
dividing the net loss by the weighted average number of common shares outstanding during the period. Diluted per share amounts reflect the weighted average number of common and dilutive shares outstanding during the period. As Click2learn had a net
loss in each of the periods presented, basic and diluted net loss per share are the same.



Excluded from the computation of diluted loss per share for the three and nine months ended September 30, 2003 are options to acquire approximately 6,010,870 shares of common stock with a weighted average exercise
price of $3.73 and warrants to purchase 6,937,055 shares of common stock with a weighted average exercise price of $3.34 because their effects would be anti-dilutive. Options to acquire approximately 6,161,452 shares of common stock with a weighted
average exercise price of $4.72 and warrants to purchase 3,633,686 shares of common stock with a weighted exercise share price of $5.75 have been excluded from the computation of diluted earnings per share for the three and nine months ended
September 30, 2002 because their effects would be anti-dilutive.



The change in common stock and additional paid-in capital reflects the stock option exercises and stock purchase for the Employee Stock Purchase Plan on July 31, 2003.



(f) Derivative Financial Instruments



Click2learn had no derivative financial instruments outstanding at September 30, 2003 or December 31, 2002.



(g) Comprehensive Loss and Accumulated Other Comprehensive Loss



The following table sets forth the components of
comprehensive loss for the periods presented below (in thousands):



|                                        |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |         |  
|--------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                        |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                        |  | 2003                             |        |   | 2002                            |   |        | 2003 |  |   | 2002   |  
|Net loss                                |  | $                                | (1,369 | ) |                                 | $ | (7,452 | )    |  | $ | (3,050 | ) |  | $ | (17,357 | )
|Foreign currency translation adjustment |  |                                  | (27    | ) |                                 |   | (27    | )    |  |   | 100    |   |  |   | (26     | )
|                                        |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |         |  
|Total comprehensive loss                |  | $                                | (1,396 | ) |                                 | $ | (7,479 | )    |  | $ | (2,950 | ) |  | $ | (17,383 | )
|                                        |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |         |  



Accumulated other
comprehensive loss at September 30, 2003 and 2002 consists of foreign currency translation adjustments.



8



---

##### Table of Contents

CLICK2LEARN, INC.



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(h) Stock-Based Compensation



Click2learn applies the intrinsic-value-based method of accounting prescribed by Accounting Principles Board Opinion No. 25
(APB 25), Accounting for Stock Issued to Employees,and related interpretations including Financial Accounting Standards Board Interpretation No. 44 (FIN 44),Accounting for Certain Transactions Involving Stock
Compensation, an interpretation of APB 25, to account for its fixed-plan stock options. Under this method, compensation expense is recorded only if the current market price of the underlying stock exceeded the exercise price on the date of the
grant. Statement of Financial Accounting Standards No. 123 (SFAS 123), Accounting for Stock-Based Compensation, established accounting and disclosure requirements using a fair-value-based method of accounting for stock-based
employee compensation plans. As allowed by SFAS 123, Click2learn has elected to continue to apply the intrinsic-value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS 123. The following table
illustrates the effect on net loss if the fair-value-based method had been applied to all outstanding and unvested awards in each period (in thousands):



|                                                                                                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                                                                                            |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                                                                                                            |  | 2003                             |        |   | 2002                            |   |        | 2003 |  |   | 2002   |  
|Net loss, as reported                                                                                                       |  | $                                | (1,369 | ) |                                 | $ | (7,452 | )    |  | $ | (3,050 | ) |  | $ | (17,357 | )
|Add stock-based employee compensation expenses included in reported net loss, net of tax                                    |  |                                  |       |   |                                 |   |       |      |  |   |       |   |  |   | 5       |  
|Deduct total stock-based employee compensation expense determined under fair-value-based method for all rewards, net of tax |  | $                                | (944   | ) |                                 | $ | (1,239 | )    |  | $ | (3,145 | ) |  | $ | (4,322  | )
|                                                                                                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |         |  
|Pro forma net loss                                                                                                          |  | $                                | (2,313 | ) |                                 | $ | (8,691 | )    |  | $ | (6,195 | ) |  | $ | (21,674 | )
|                                                                                                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |         |  
|Basic and diluted net loss per share:                                                                                       |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |         |  
|As reported                                                                                                                 |  | $                                | (0.04  | ) |                                 | $ | (0.30  | )    |  | $ | (0.11  | ) |  | $ | (0.71   | )
|Pro forma                                                                                                                   |  | $                                | (0.07  | ) |                                 | $ | (0.35  | )    |  | $ | (0.22  | ) |  | $ | (0.89   | )



(i) New Accounting
Policies



In November 2002, the EITF reached a consensus
on Issue No. 00-21 (EITF 00-21), Revenue Arrangements with Multiple Deliverables. EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue generating
activities. EITF 00-21 will be effective for periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have a material impact on Click2learns financial position and results of operations.



In January 2003, the FASB issued Interpretation No. 46 (FIN 46),
Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51. FIN 46 addresses the consolidation by business enterprises of variable interest entities as defined in FIN 46. FIN 46 applies immediately to variable interests in
variable interest entities created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. As amended by FASB Staff Position (FSP) No. FIN 46-6, FIN 46 is effective for variable
interests in a variable interest entity created before February 1, 2003 at the end of the first interim or annual period ending after December 15, 2003 (the end of fiscal 2003, December 31, 2003 for Click2learn). Click2learn is currently reviewing
the potential impact of FIN 46 on its consolidated financial statements.



In April 2003, the FASB issued SFAS No. 149 (SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and
reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to



9



---

##### Table of Contents

CLICK2LEARN, INC.



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



as derivatives) and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and
hedging relations designated after June 30, 2003, except for those provisions of SFAS No. 149, which relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003. For those issues, the
provisions that are currently in effect should continue to be applied in accordance with their respective effective dates. In addition, certain provisions of SFAS No. 149, which relate to forward purchases or sales of when-issued securities or other
securities that do not yet exist, should be applied to both existing contracts and new contracts entered into after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on Click2learns financial statements.



In May 2003, the FASB issued SFAS No. 150 (SFAS No. 150),
Accounting for Certain Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and
equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within the scope of SFAS No. 150 as a liability. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is
effective for Click2learn beginning September 1, 2003. The adoption of SFAS No. 150 did not have a material effect on Click2learns financial statements.



In July 2003, the EITF reached a consensus on Issue 03-5 (EITF 03-5), Applicability of AICPA Statement of Position 97-2 Software
Revenue Recognition (SOP 97-2) to Non-Software Deliverables. The consensus was reached that non-software deliverables are included within the scope of SOP 97-2 if they are included in an arrangement that contains software that is essential
to the non-software deliverables functionality. This consensus is effective at the beginning of the first interim period beginning after August 13, 2003. Click2learn does not expect the adoption of EITF 03-5 to have a material impact on its
financial position or results of operations.



In July 2003, the
EITF reached a consensus on Issue 03-7 (EITF 03-7), Accounting for the Settlement of the Equity-Settled Portion of a Convertible Debt Instrument that Permits or Requires the Conversion Spread to be Settled in Stock (Instrument C of
EITF Issue No. 90-19, Convertible Bonds with Issuer Option to Settle for Cash upon Conversion). The consensus was reached that upon settlement of a security with the characteristics of Instrument C in Issue 90-19 by payment of the
accreted value of the obligation (recognized liability) in cash and settlement of the conversion spread (unrecognized equity instrument) with stock, only the cash payment should be considered in the computation of gain or loss on extinguishment of
the recognized liability. That is, any shares transferred to settle the embedded equity instrument (referred to as the excess conversion spread in Issue 90-19) would not be considered in the settlement of the debt component. This consensus is
effective for settlement transactions entered into on or after the beginning of Click2learns first interim period beginning after August 13, 2003. Click2learn does not expect the adoption of EITF 03-7 to have a material impact on its financial
position or results of operations.



(j) Reclassifications



Amortization of purchased technology has been
reclassified, as follows, from research and development costs to platform cost of revenue since it relates to products currently being sold by Click2learn:



|                                     |  |                                          |     |                                         |   |      |  |      |     |  |   |    
|------------------------------------ |  | ---------------------------------------- | --- | --------------------------------------- | - | ---- |  | ---- | --- |  | - | ---
|                                     |  | For the Three Months Ended September 30, |     | For the Nine Months Ended September 30,
|                                     |  | 2003                                     |     | 2002                                    |   | 2003 |  | 2002
|Amortization of purchased technology |  | $                                        | 353 |                                         | $ | 117  |  | $    | 823 |  | $ | 350
|                                     |  |                                          |     |                                         |   |      |  |      |     |  |   |    



10



---

##### Table of Contents

CLICK2LEARN, INC.



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 2:  DISCONTINUED OPERATIONS



During January 2002, Click2learn sold certain assets of its content development business, including equipment and a customer
list to NIIT (USA), Inc. (NIIT), the U.S. operations of NIIT Limited, a global custom software development firm, under an Asset Purchase agreement for $1 million, resulting in a gain of $927,000 based on the book value of those assets.
As a result of the transaction with NIIT, Click2learn significantly reduced the headcount of its custom content development business and closed certain facilities. During the third quarter of 2002, Click2learn completed the discontinuation of its
remaining custom content development business by early termination of its contract to develop content for the Washington Army National Guard. As part of the negotiation to terminate the contract, Click2learn agreed to forego the collection of
$4.5 million in accounts receivable. Results related to its custom content development business for the year ended December 31, 2002 and prior years have been reclassified as income (loss) from discontinued operations.



Summary operating results of the discontinued operations were as follows (in
thousands):



|                                  |  |                                               |        |   |                                              |   |        |  
|--------------------------------- |  | --------------------------------------------- | ------ | - | -------------------------------------------- | - | ------ | -
|                                  |  | For the Three Months Ended September 30, 2002 |        |   | For the Nine Months Ended September 30, 2002 |  
|Revenues                          |  | $                                             |       |   |                                              | $ | 248    |  
|Cost of revenues                  |  | $                                             | (474   | ) |                                              | $ | (2,717 | )
|Operating expenses                |  | $                                             | (4,475 | ) |                                              | $ | (6,058 | )
|Other income                      |  | $                                             |       |   |                                              | $ | 927    |  
|                                  |  |                                               |        |   |                                              |   |        |  
|Loss from discontinued operations |  | $                                             | (4,949 | ) |                                              | $ | (7,600 | )
|                                  |  |                                               |        |   |                                              |   |        |  



NOTE 3:  BANK CREDIT
FACILITY



In December 2002, Click2learn consolidated its
existing $4 million working capital line of credit and $1 million term loan facility with Silicon Valley Bank into a $10 million working capital line. Under the facility Click2learn will continue to repay the remaining balance of the term loan
in accordance with the original terms (monthly payments of $41,666.67 plus interest ending October 1, 2003), but the unpaid balance of the term loan will not be available under the line of credit. The term loan and the working capital line will bear
interest at the greater of Silicon Valley Bank prime rate plus 2.25% or 7.0% and have minimum monthly interest of $8,500 per month regardless of the loan balances.



The credit facility is collateralized by a security interest in all of Click2learns assets. Covenants in the loan
agreements include restrictions on Click2learns ability to pay dividends or make other distributions, make acquisitions or investments, merge or consolidate with others or dispose of assets, as well as financial covenants limiting the amount
of net losses during any three month period and requiring Click2learn to maintain certain levels of minimum tangible net worth. If not renewed, the working capital line terminates and any advances made are due on December 6, 2004.



Under the working capital line of credit, the principal amount of $3,603,251
was outstanding as of September 30, 2003. Borrowings outstanding under the term loan were $41,667 at September 30, 2003 all of which is repayable in 2003. As of September 30, 2003, Click2learn was in compliance with the loans covenants.Aggregate short-term debt of $3.6 million at September 30, 2003 is presented net of debt discount of $111,000 attributable to the issuance of common stock warrants.



11



---

##### Table of Contents

CLICK2LEARN, INC.



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



NOTE 4:  GUARANTEES



Click2learn adopted FIN 45 during the quarter ended December 31, 2002. In the ordinary course of business, Click2learn is
not subject to potential obligations under guarantees that fall within the scope of FIN 45 except for standard indemnification and warranty provisions that are contained within many of our customer license and service agreements, and give rise only
to the disclosure requirements prescribed by FIN 45.



Indemnification and warranty provisions contained within our customer license and service agreements are generally consistent with those prevalent in our industry. The duration of our product warranties generally does not exceed 90 days
following delivery of our products. We have not incurred significant obligations under customer indemnification or warranty provision historically and do not expect to incur significant obligations in the future. Accordingly, we do not maintain
accruals for potential customer indemnification or warranty-related obligations.



NOTE 5:  SEGMENT INFORMATION



Click2learns internal reporting includes the three reportable segments: Platforms, Tools, and Content Services. Platforms revenue includes software licenses, subscription and hosting fees, implementation, customization, consulting,
training and support related to the Aspen suite, the Ingenium learning management system, which is the precursor product to the Aspen Learning Management Server, and the e-Learning Network, which is no longer offered to new customers. Tools revenue
includes software licenses, technical support and training related to the ToolBook line of products. Content Services revenue includes the placement of Click2learn personnel at customer sites on a time and material basis, the resale of third party
off the shelf training content and license and hosting fees for our Rapid e-Learning Development System, which is no longer offered to new customers.



Click2learns operating committee, which includes its Chief Executive Officer and Chief Financial Officer, has been identified as the Chief Operating
Decision Maker (CODM) as it assesses the performance of the business units and decides how to allocate resources to the business units. Segment income is the measure of profit and loss that the CODM uses to assess performance and make decisions.
Segment income represents revenue less cost of revenue incurred within the operating segments as presented in Click2learns consolidated statements of operations. Click2learn does not allocate operating expenses including research and
development, sales and marketing, general and administrative, or amortization of goodwill to its operating segments. In addition, other income (expense) are not allocated to operating segments.



There is no intersegment revenue. Click2learns CODM does not review
total assets or depreciation and amortization by operating segment. The accounting policies for reported segments are the same as Click2learn as a whole.



Revenues by geographic region which are based on the location of the customers are as follows (in thousands):



|         |  |                                          |       |                                         |   |       |  |      |        |  |   |       
|-------- |  | ---------------------------------------- | ----- | --------------------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|         |  | For the Three Months Ended September 30, |       | For the Nine Months Ended September 30,
|         |  | 2003                                     |       | 2002                                    |   | 2003  |  | 2002
|Revenue: |  |                                          |       |                                         |   |       |  |      |        |  |   |       
|US       |  | $                                        | 6,727 |                                         | $ | 6,404 |  | $    | 20,732 |  | $ | 19,838
|UK       |  |                                          | 323   |                                         |   | 56    |  |      | 1,548  |  |   | 538   
|Other    |  |                                          | 463   |                                         |   | 479   |  |      | 1,363  |  |   | 1,475 
|         |  |                                          |       |                                         |   |       |  |      |        |  |   |       
|         |  | $                                        | 7,513 |                                         | $ | 6,939 |  | $    | 23,643 |  | $ | 21,851
|         |  |                                          |       |                                         |   |       |  |      |        |  |   |       



12



---

##### Table of Contents

CLICK2LEARN, INC.



NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Long-lived assets by geographic location are as follows (in thousands):



|                   |  |                    |       |                   |   |      
|------------------ |  | ------------------ | ----- | ----------------- | - | -----
|                   |  | September 30, 2003 |       | December 31, 2002
|Long-lived assets: |  |                    |       |                   |   |      
|US                 |  | $                  | 7,204 |                   | $ | 8,596
|Other              |  |                    | 236   |                   |   | 131  
|                   |  |                    |       |                   |   |      
|                   |  | $                  | 7,440 |                   | $ | 8,727
|                   |  |                    |       |                   |   |      



Long-lived assets represent property,
plant, and equipment, goodwill and other intangible assets, net of accumulated depreciation and amortization.



NOTE 6:  SUBSEQUENT EVENTS



On October 20, 2003, Click2learn entered into an Agreement and Plan of Reorganization with Docent, Inc, which was approved by Click2learns board of directors. Under the terms of the agreement, Click2learn and
Docent will be acquired by a new corporate entity. Stockholders of Click2learn will receive 0.4144 shares in the new company for each common share held on the closing date or approximately 52% of the total outstanding common stock of the new
company, without taking into account the exercise of options prior to the closing date. Stockholders of Docent will receive .9525 shares of common stock in the new company for each common share held on the closing date, or approximately 48% of the
total outstanding common stock of the new company, without taking into account the exercise of options prior to the closing date. Outstanding options and warrants will be converted into options and warrants for the purchase of shares in the new
corporation in accordance with the same exchange ratio. The transaction is anticipated to be a tax-free reorganization and/or a tax-free exchange for income tax purposes. The consummation of the merger is subject to the approval of
Click2learns stockholders and the stockholders of Docent and other customary closing conditions.



13



---

##### Table of Contents

Item 2.  Managements Discussion and Analysis of Financial Condition and Results of Operations



This Quarterly Report includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This
Act provides a safe harbor for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary
statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact we make in this Quarterly Report are forward-looking. Such forward-looking
statements involve risks and uncertainties, including, among other things, statements regarding our anticipated costs and expenses and revenue mix. Such forward-looking statements include, among others, those statements including the words
expect, anticipate, intend, believe and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to
such differences include, but are not limited to those discussed in the section Managements Discussion and Analysis of Financial Condition and Results of Operations  Factors That May Affect Future Results of Operations. You
are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or
reflect events or circumstances after the date of this document.



Overview



We are a leading developer and
provider of enterprise learning solutions for companies, government agencies and educational institutions. We design, develop, market, license and support an integrated suite of enterprise software products and related services that allow our
customers to cost-effectively create, personalize and manage the delivery of learning and knowledge content. Our flagship product, the Aspen Enterprise Productivity Suite, combines collaborative content development, comprehensive learning management
and virtual classroom systems into a single, integrated product suite with a unified architecture and user experience. We provide our products and services to customers across a broad range of industries including financial services, accounting,
healthcare, insurance, technology, manufacturing, telecommunications, transportation, utilities, government and education.



We report revenue in three separate categories related to the different components of our business:



| |  | Platforms revenue includes software licenses, subscription and hosting fees, implementation, customization, consulting, training and support related to the Aspen suite, our Ingenium
learning management system, which is the precursor product to the Aspen Learning Management Server, and our e-Learning Network, which is no longer offered to new customers.
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Tools revenue includes software licenses, technical support and training related to our ToolBook line of products.
| | - | ------------------------------------------------------------------------------------------------------------------



| |  | Content Services revenue includes the placement of Click2learn personnel at customer sites on a time and material basis, the resale of third party off the shelf training content and
license and hosting fees for our Rapid e-Learning Development System, which is no longer offered to new customers. During 2002 we discontinued our custom content development business, which had been the primary source of revenue from Content
Services in prior years. Prior years revenue and expenses for this portion of the business have been reclassified as income or loss from discontinued operations.
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Recent Developments



On October 20, 2003, we announced an agreement to combine with Docent, Inc. (Docent) in a merger of equals transaction. The proposed
transaction is anticipated to close in the first quarter of 2004. The announcement of the transaction and our actions taken in preparing for the submission of the transaction to the stockholders and in planning for the integration with Docent may
impact our results of operations and liquidity in future periods. For more information on the proposed merger see Other Information on page 32 and for more



14



---

##### Table of Contents

information on the risks associated with the merger agreement see Factors That May Affect Future Results of Operations on page 23. In connection
with the proposed merger, Docent and we expect to file a joint proxy statement/prospectus with the Securities and Exchange Commission. The joint proxy statement/prospectus will be mailed to all holders of our stock and will contain important
information about us, Docent and the proposed transaction, risks relating to the transaction and the combined company, and related matters. We urge all of our stockholders to read the joint proxy statement/prospectus when it becomes available.



Critical Accounting Policies and Estimates



Our critical accounting policies and estimates are as follows:



| |  | Revenue recognition
| | - | -------------------



| |  | Estimating allowances for sales returns and the allowance for doubtful accounts
| | - | -------------------------------------------------------------------------------



| |  | Valuation of goodwill
| | - | ---------------------



| |  | Valuation of long-lived assets
| | - | ------------------------------



Revenue Recognition.We recognize revenue pursuant to the requirements of Statement of Position No. 97-2, Software Revenue Recognition
(SOP 97-2), as amended by Statement of Position No. 98-9, Software Revenue Recognition with Respect to Certain Arrangements. Under SOP 97-2, revenue attributable to an element in a customer arrangement is recognized when
persuasive evidence of an arrangement exists and delivery has occurred, provided the fee is fixed or determinable, collectibility is probable and the arrangement does not require significant customization of the software.



For all sales, we use either a binding purchase order or signed agreement,
depending on the nature of the transaction, as evidence of an arrangement. Sales through our significant resellers are evidenced by a master agreement governing the relationship.



For software license fees in single element arrangements and multiple element arrangements, which do not include
customization or consulting services, delivery typically is deemed to occur when the product is shipped to customers.



At the time of each transaction, we assess whether the fee associated with our revenue is fixed and determinable and whether or not collection is
probable. We assess whether the fee is fixed and determinable based on the payment terms associated with the transaction. If a significant portion of a fee is due after our normal payment terms, based upon a variable matrix such as a minimum level
of distribution or subject to refund (other than refunds for warranty claims or our uncured defaults), we account for the fee as not being fixed and determinable. In these cases, we defer revenue and recognize it when it becomes due and payable.



We assess the probability of collection based on a number of
factors, including past transaction history with the customer and the current financial condition of the customer. We do not request collateral from our customers. If we determine at the time of the transaction that collection of a fee is not
probable, we defer revenue until payment is received.



For
multiple element arrangements, when company-specific objective evidence of fair value exists for all of the undelivered elements of the arrangement, but does not exist for one or more of the delivered elements in the arrangement, we recognize
revenue under the residual method. Under the residual method, at the outset of the arrangement with a customer, we defer revenue for the fair value of its undelivered elements such as consulting services and product support and upgrades, and
recognize the revenue for the remainder of the arrangement fee attributable to the elements initially delivered, such as software licenses, when the criteria in SOP 97-2 have been met. Company-specific objective evidence is established for support
and upgrades of standard products for which no installation or customization is required based upon the amounts we charge when support and upgrades are



15



---

##### Table of Contents

sold separately. For multiple element arrangements involving installation or customization, company-specific objective evidence is established for support
and maintenance arrangements if our customers have an optional annual renewal rate specified in the arrangement and the rate is substantive. Company-specific objective evidence is established for consulting and installation services based on the
hourly rates we charge for our employees when they are performing these services provided we have the ability to accurately estimate the hours required to complete a project based upon our experience with similar projects.



Professional services revenue is recognized from fixed price contracts as
services are provided or by using the percentage-of-completion method of accounting, based on the ratio of labor costs incurred to the total estimated project cost, for individual fixed-price contracts. Provisions for any estimated losses on
uncompleted contracts are made in the period in which such losses become evident. Professional services revenue from time and materials contracts and training services is recognized as revenue as services are performed.



We recognize revenue from non-refundable minimum royalty agreements from
distributors or resellers upon delivery of product to the distributor or reseller, provided no significant obligations remain outstanding and the conditions of SOP 97-2 have been met. If minimum royalties are exceeded, the additional royalties are
recognized as revenue when earned, based on the contractual reporting obligations.



Revenue from subscription licenses, hosting agreements and support agreements is recognized on a straight-line basis over the life of the contract. We typically bill these contracts in advance and record the deferred
amounts in deferred revenue.



Allowances for Sales
Returns and Doubtful Accounts.The preparation of financial statements requires us to make estimates and assumptions that affect the reported amount of assets and disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reported period. Specifically, we must make estimates of future product returns related to current period product revenue. We analyze historical returns, current economic trends,
and changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns and other allowances. Significant judgments and estimates must be made and used in connection with establishing reserves for sales
returns and the allowance for doubtful accounts in any accounting period. Material differences may result in the amount and timing of our revenue for any period if we made different judgments or utilized different estimates. Similarly, we must make
estimates of the uncollectability of our accounts receivable. We specifically analyze accounts receivable greater than 90 days and analyze historical bad debts, customer concentrations, customer credit-worthiness and current economic trends when
evaluating the adequacy of the allowance for doubtful accounts.



Valuation of Goodwill.We assess the impairment of goodwill on an annual basis or whenever events or changes in circumstances indicate the fair value of a reporting unit to which goodwill relates is less than its carrying value.
Factors we consider important which could trigger an impairment review include poor economic performance relative to expected historical or projected future operating results, significant negative industry, economic or company specific trends and
changes in the manner of our use of the assets or the plans for our business. If we were to determine that the fair value of a reporting unit was less than its carrying value, including goodwill based upon the annual test or the existence of one or
more of the above indicators of impairment, then we would measure impairment based on a comparison of the implied fair value of reporting unit goodwill with the carrying amount of goodwill. The implied fair value of goodwill is determined by
allocating the fair value of a reporting unit to its assets (recognized and unrecognized) and liabilities in a manner similar to a purchase price allocation. The residual fair value after this allocation is the implied fair value of reporting unit
goodwill. To the extent the carrying amount of reporting unit goodwill is greater than the implied fair value of reporting unit goodwill, we would record an impairment charge for the difference.



Valuation of Long Lived Assets. SFAS 144 provides a single accounting
model for disposal of long-lived assets. SFAS 144 also changes the criteria for classifying an asset as held for sale and broadens the scope of businesses to be disposed of that qualify for reporting as discontinued operations and changes the timing
of



16



---

##### Table of Contents

recognizing losses on such operations. We adopted SFAS 144 on January 1, 2002. The adoption of SFAS 144 did not affect our consolidated financial position or
results of operations as of January 1, 2002. The broadened definition of discontinued operations with SFAS 144 has affected the presentation and disclosure of our results of operations for the year ended 2002 and prior years presented for
comparison. In accordance with SFAS 144, we review long-lived assets, such as property, plant, and equipment, and purchased intangibles subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. We measure recoverability of assets to be held and used by comparing the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount
of an asset exceeds its estimated future cash flows, we recognize an impairment charge as the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of would be separately presented in the balance
sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held for sale would be presented separately in the appropriate asset
and liability sections of the balance sheet.



Results of Operations for the
Three and Nine Months Ended September 30, 2003 Compared to the Three and Nine Months Ended September 30, 2002



In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment and Disposal of Long-lived Assets, the
financial statements and managements discussion and analysis present results from continuing operations with revenue and expenses related to our discontinued custom content development business as loss from discontinued operations. See
Loss from Discontinued Operations for additional information regarding the discontinuance of the custom content development business and the amount of revenue and costs that have been reclassified to loss from discontinued operations.



Revenue.For the three and nine-month periods ended
September 30, 2003 total revenue increased 8% in each period to $7.5 million and $23.6 million as compared to $6.9 million and $21.9 million for the comparable periods ended September 30, 2002. The increase in revenue is attributed to revenue growth
from the Platforms category offset by declining revenue from the Tools and Content Services categories.



Platforms revenue grew 22% in each period to $6.4 million and $19.9 million for the three and nine-month periods ended September 30, 2003 as compared to
$5.3 million and $16.2 million for the comparable periods ended September 30, 2002. In general list pricing for Platform license and services was unchanged as compared to 2002 levels, however, due in large part to the improved high tech spending
environment discounting decreased to less than 50% where through all of 2002 we discounted greater than 50%. Platform related license revenue grew 9% to $2.2 million and service revenue 30% to $4.2 million for the period as compared to $2.1 million
and $3.2 million for the period ended September 30, 2002. For the nine-month period license revenue declined 2% to $6.4 million and services grew 39% to $13.5 million as compared to $6.5 million and $9.7 million in 2002. Aspen related revenue
represented 98% of total Platform revenue for the three and nine month periods ended September 30, 2003 or $6.3 million and $19.5 million. This compares to 93% for the three-month period or $4.9 million and 84% or $13.6 million for the
nine-month period in 2002. Legacy revenue derived from the Ingenium and e-Learning Network products fell to $111,000 for the three-month period and $368,000 for the nine months ended September 30, 2003. This was down due to the replacement by Aspen
as our primary offering from $351,000 for the three-month period and $2.6 million for the nine-month period ended September 30, 2002. We believe that future growth in total revenue is dependent on continuing to increase Platforms revenue.



Tools revenue declined 26% and 34% to $672,000 and
$2.2 million, $381,000 and $1.2 million from license and $291,000 and $1.0 million from services for the three and nine-month periods ended September 30, 2003 as compared to $907,000 and $3.4 million, $462,000 and $1.9 million from license and
$445,000 and $1.5 million from services for the comparable periods ended September 30, 2002. While new product releases may result in increased customer demand and higher Tools revenue in future periods, we believe that Tools revenue will continue
to decline in future periods if new releases of the products are not met with renewed customer demand.



17



---

##### Table of Contents

Content Services revenue declined 46% and 30% to $398,000 and $1.5 million for the three and
nine-month periods ended September 30, 2003 as compared to $737,000 and $2.2 million for the comparable periods ended September 30, 2002. Current Content Services revenue is derived primarily from the placement of temporary personnel at our
clients locations on an hourly basis. Due to the economic downturn, demand for temporary labor resources, which is typically lower in the summer months, is down overall. We expect Content Services revenue to remain at current levels or
continue to decline in future periods.



International
revenues for the three and nine month periods ended September 30, 2003 represented 11% and 9% respectively. The increase in percent of revenue related to the three-month period was due primarily to lower overall revenue in the period as compared to
the first two quarters of 2003 and not due to a significant increase in international revenues.



Cost of Revenue. For the three and nine-month periods ended September 30, 2003 total cost of revenue increased 9% and decreased 4% to $2.3 million
and $7.1 million as compared to $2.2 million and $7.4 million for the same periods ended September 30, 2002. The increase over the respective three-month periods is primarily due to increased Platforms costs resulting from higher Platforms revenue
and costs related to amortization of purchased technology, offset by decreases in Tools and Content Services costs as a result of lower revenue over these periods. The decrease over the respective nine-month periods is primarily due to declines in
Tools and Content Services costs as a result of lower revenue, offset by increased costs related to our Platform revenue.



Platform cost of revenue increased 39% and 16% to $1.8 million and $5.3 million for the three and nine-month periods ended September 30, 2003 as compared
to $1.3 million and $4.6 million for the same periods ended September 30, 2002. The increase was due to higher Platform revenue and increased costs related to the amortization of purchased technology, which increased $240,000 over the three-month
period ended September 30, 2002. Platform cost of revenue as a percentage of Platform revenue was 28% and 27% for the three and nine-month periods ended September 30, 2003 up from 25% and down from 28% for the same periods ended September 30,
2002. The increase in costs over the three-month period ended September 30, 2003 was due primarily to increased costs for amortization of purchased technology of $240,000 related to our Virtual Classroom Server product and due to higher services
revenue weve increased our staffing levels resulting in $250,000 of higher salary expense. The increase in costs over the nine-month period was due to $240,000 of higher amortization expense mentioned above as well as $450,000 of higher labor
expense related to increased staffing required to deliver higher services revenue.



Tools cost of revenue declined 48% and 58% to $140,000 and $398,000 for the three and nine-month periods ended September 30, 2003 as compared to $268,000 and $950,000 for the same periods ended September 30,
2002. The decline is a result of lower Tools revenue. Tools cost of revenue as a percentage of Tools revenue was 21% and 18% for the three and nine-month periods ended September 30, 2003 down from 30% and 28% for the same periods ended September 30,
2002. The decline in costs as a percentage of revenue was due primarily to a decline in services revenues.



Content Services cost of revenue declined 34% and 26% to $383,000 and $1.4 million for the three and nine-month periods ended September 30, 2003 as
compared to $577,000 and $1.9 million for the same periods ended September 30, 2002. The decline is a result of lower Content Services revenue. Content cost of revenue as a percentage of Content Services revenue was 96% and 90% for the three and
nine-month periods ended September 30, 2003 up from 78% and 85% for the same periods ended September 30, 2002. The increase in costs as a percentage of revenue was due primarily to a lower revenue base with which to absorb the groups fixed
costs of approximately $70,000 per quarter.



Operating Expenses



Research and Development. For the three and
nine-month periods ended September 30, 2003 total research and development cost declined 10% and 27% to $1.7 million and $4.7 million as compared to $1.9 million and



18



---

##### Table of Contents

$6.4 million for the same periods ended September 30, 2002. The decline is a result of shifting payroll to India where individual salaries are lower than
U.S.A. equivalents. This allowed us to increase total research and development staff while lowering compensation cost in 2003 approximately $200,000 and $1.7 million as compared to the three and nine-month periods ended September 30, 2002. We
anticipate that research and development costs will increase during the remainder 2003 as a result of increased staffing necessary for upcoming releases of the Aspen platform. In prior periods we had classified the amortization of purchased
technology as research and development costs. The costs of this amortization have been reclassified as cost of Platforms revenue for the current and historical periods reported.



Sales and Marketing.For the three and nine-month periods ended September 30, 2003 total sales and marketing cost
declined 10% and 19% to $3.3 million and $10.5 million as compared to $3.7 million and $13.0 million for the same periods ended September 30, 2002. The decline is a result of headcount reductions of 22% for the three months and 35% for the nine
months ended September 30, 2003, which resulted in decreased compensation and travel expenses of approximately $400,000 and $2.5 million as compared to the three and nine-month periods ended June 30, 2002.



General and Administrative. Total general and administrative cost
increased 24% to $1.5 million as compared to $1.2 million for the three-month period ended September 30, 2003 as compared to the same period the prior year, while costs for the nine-month period ended September 30, 2003 were unchanged from the same
period in the prior year at $4.2 million. During the three-month period ended September 30, 2002 spending was reduced in all operating expense categories in order to lower the companies use of cash; in 2003, such reductions were unsustainable and as
a result there was no single category of operating expense primarily responsible for the $300,000 increase for the same period in 2003. For the nine-month period ended September 30, 2003 while costs were unchanged from 2002 levels salary expense was
$250,000 lower and general operating expenses $250,000 higher primarily due to the unsustainable cost reduction measures in the three-month period ended September 30, 2003. We expect general and administrative costs to increase in the coming period
as a result of expenses incurred in connection with our proposed merger with Docent, regardless of the consummation of the transaction.



Other Income (Expense). For the three and nine-months ended September 30, 2003 other expenses were $8,000 and $101,000. These amounts were
primarily interest on borrowing from Silicon Valley Bank. For the three and nine-months ended September 30, 2002, other income was $15,000 and $28,000, which was net interest income.



Equity in Losses of Affiliate. Losses from affiliates relate to our joint venture with Softbank in Japan, Click2learn
Japan KK. We use the equity method of accounting whereby we record our ownership portion of the joint ventures net income or loss. For the three and nine month periods ended September 30, 2003 our losses from affiliates were $25,000 and $75,000
compared to $25,000 and $175,000 for the periods ended September 30, 2002.



Loss from Discontinued Operations. In 2003 we have not had losses from discontinued operations. For the three and nine month periods ended September 30, 2002 losses from the discontinuation of our custom
development business were $4.9 million and $7.6 million respectively.



Income Taxes. For the three and nine months ended September 30, 2003, we recorded income tax expense of $8,000 and $26,000 related to foreign income taxes. For the three and nine months ended September 30, 2002, no income tax expense
was recorded.



Recent Accounting Pronouncements



In November 2002, the EITF reached a consensus on Issue No. 00-21
(EITF 00-21), Revenue Arrangements with Multiple Deliverables. EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which the vendor will perform multiple revenue generating activities. EITF
00-21 will be effective for periods beginning after June 15, 2003. The adoption of EITF 00-21 did not have a material impact on Click2learns financial position and results of operations.



19



---

##### Table of Contents

In January 2003, the FASB issued Interpretation No. 46 (FIN 46), Consolidation of Variable
Interest Entities, an Interpretation of ARB No. 51. FIN 46 addresses the consolidation by business enterprises of variable interest entities as defined in FIN 46. FIN 46 applies immediately to variable interests in variable interest entities
created after January 31, 2003, and to variable interests in variable interest entities obtained after January 31, 2003. As amended by FASB Staff Position (FSP) No. FIN 46-6, FIN 46 is effective for variable interests in a variable
interest entity created before February 1, 2003 at the end of the first interim or annual period ending after December 15, 2003 (the end of fiscal 2003, December 31, 2003 for Click2learn). Click2learn is currently reviewing the potential impact of
FIN 46 on its consolidated financial statements.



In April
2003, the FASB issued SFAS No. 149 (SFAS No. 149), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. SFAS No. 149 amends and clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS No. 133. SFAS No. 149 is effective for contracts entered into or modified after June 30, 2003, and
hedging relations designated after June 30, 2003, except for those provisions of SFAS No. 149, which relate to SFAS No. 133 implementation issues that have been effective for fiscal quarters that began prior to June 15, 2003. For those issues,
the provisions that are currently in effect should continue to be applied in accordance with their respective effective dates. In addition, certain provisions of SFAS No. 149, which relate to forward purchases or sales of when-issued securities or
other securities that do not yet exist, should be applied to both existing contracts and new contracts entered into after June 30, 2003. The adoption of SFAS No. 149 did not have a material effect on Click2learns financial statements.



In May 2003, the FASB issued SFAS No. 150 (SFAS No.
150), Accounting for Certain Instruments with Characteristics of both Liabilities and Equity. SFAS No. 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that an issuer classify a financial instrument that is within the scope of SFAS No. 150 as a liability. SFAS No. 150 is effective for financial instruments entered into or modified after May 31, 2003,
and otherwise is effective for Click2learn beginning September 1, 2003. The adoption of SFAS No. 150 did not have a material effect on Click2learns financial statements.



In July 2003, the EITF reached a consensus on Issue 03-5 (EITF 03-5), Applicability of AICPA Statement of
Position 97-2 Software Revenue Recognition (SOP 97-2) to Non-Software Deliverables. The consensus was reached that non-software deliverables are included within the scope of SOP 97-2 if they are included in an arrangement that
contains software that is essential to the non-software deliverables functionality. This consensus is effective at the beginning of the first interim period beginning after August 13, 2003. Click2learn does not expect the adoption of EITF 03-5
to have a material impact on its financial position or results of operations.



In July 2003, the EITF reached a consensus on Issue 03-7 (EITF 03-7), Accounting for the Settlement of the Equity-Settled Portion of a Convertible Debt Instrument that Permits or Requires the
Conversion Spread to be Settled in Stock (Instrument C of EITF Issue No. 90-19, Convertible Bonds with Issuer Option to Settle for Cash upon Conversion). The consensus was reached that upon settlement of a security with the
characteristics of Instrument C in Issue 90-19 by payment of the accreted value of the obligation (recognized liability) in cash and settlement of the conversion spread (unrecognized equity instrument) with stock, only the cash payment should be
considered in the computation of gain or loss on extinguishment of the recognized liability. That is, any shares transferred to settle the embedded equity instrument (referred to as the excess conversion spread in Issue 90-19) would not be
considered in the settlement of the debt component. This consensus is effective for settlement transactions entered into on or after the beginning of Click2learns first interim period beginning after August 13, 2003. Click2learn does not
expect the adoption of EITF 03-7 to have a material impact on its financial position or results of operations.



20



---

##### Table of Contents

Liquidity and Capital Resources



At September 30, 2003, our principal source of liquidity was $14.9 million of cash and $9.4 million of accounts receivable,
up from $3.6 million of cash and down from $10.8 million of accounts receivable on December 31, 2002. The change in cash is due primarily to the sale of common stock and warrants in June of 2003 that resulted in net cash proceeds of approximately
$11.9 million. The change in accounts receivable is due primarily to improved collection efforts and the write-off of a receivable of approximately $500,000 from an international customer. We believe our risk on current Platform-related receivables
is low given the general financial strength of our customers. At September 30, 2003 we had no significant collectibility or billing problems with any major customers or classes of customers.



Although we have not made any significant changes in our payment terms, as a
result of the discontinuance of our custom content development business we are able to collect more quickly on our receivables generally than in prior periods, when a significant portion of our revenue was from custom content development contracts.
This is because a typical custom development contract was invoiced on the achievement of contract milestones, although revenue was recognized using the percentage of completion method as the services were performed. As a result, there was often
significant time elapsed between the performance of the services and invoicing the client. Thus, the receivables from such contracts remained uncollected for longer periods than those from software licenses or other services. While we expect to be
able to collect on our receivables more quickly going forward, we may offer extended payment terms to customers in certain circumstances from time to time. To the extent that we offer such extended payment terms, they will result in a longer
collection period for accounts receivable and slower cash inflows from operations.



Based on our current cash balance, we anticipate that our cash and cash equivalents will be sufficient to meet our working capital needs and capital expenditures for at least the next 12 months. However, we will
continue to monitor our cash and liquidity and will seek additional financing or make additional expense reductions if it becomes required.



Net cash used for continuing operating activities was $740,000 in the nine months ended September 30, 2003 down from $2.2 million for the same period
2002. The change was due primarily to increased revenue and lower overall expenses in 2003 as compared to 2002.



Net cash used in investing activities was $652,000 in the nine months ended September 30, 2003. Net cash used in investing activities was primarily used
for purchases of equipment at our India office. As of September 30, 2003, we had no material commitments for capital expenditures and had commitments under non-cancelable operating leases with terms in excess of one year of $5.8 million through
2008.



Cash provided by financing activities was $12.6 million
in the nine months ended September 30, 2003, resulting primarily from draws against the Silicon Valley Bank credit facility, net of payments on debt, of approximately $351,000; net cash proceeds of approximately $11.9 million from the sale of common
stock and warrants in June; and approximately $373,000 received from purchases under our Employee Stock Purchase Plan and stock option exercises. Cash from borrowings was approximately $21.6 million, while cash used for payments on debt was $21.3
million in the nine months ended September 30, 2003.



In
December 2002 we consolidated our existing $4 million working capital line of credit and $1 million term loan facility with Silicon Valley Bank into a $10 million working capital line. Under the facility we will continue to repay the remaining
balance of the term loan in accordance with the original terms (monthly payments of $41,666.67 plus interest ending October 1, 2003), and the unpaid balance of the term loan will not be available for new loans under the line of credit. The term loan
and the working capital line will bear interest at the greater of Silicon Valley Bank prime rate plus 2.25% or 7.0% and have minimum monthly interest of $8,500 per month regardless of the loan balances. The credit facility is collateralized by a
security interest in all of our assets. Covenants in the loan agreements include restrictions on our ability to pay dividends or make other distributions, make acquisitions or investments, merge or consolidate with others or dispose of assets, as
well as



21



---

##### Table of Contents

financial covenants limiting the amount of net losses during any three-month period to $1.6 million and requiring us to maintain certain levels of minimum
tangible net worth as follows for the fiscal quarters ending: September 30, 2003: $5,000,000; December 31, 2003 and each fiscal quarter ending thereafter: $4,500,000 plus (i) 100% of all consideration received by us for equity securities and
subordinated debt, plus (ii) 50% of our net income in each fiscal quarter during the loan term. The failure to meet those covenants could prevent us from accessing the working capital line and result in the acceleration of any balances under the
working capital line and term loan. On October 20, 2003 we announced that we had signed an agreement to merge with Docent, Inc., Silicon Valley Bank has notified us that they do not view this announcement as a breach of our loan covenants. If not
renewed the working capital line terminates and any advances made are due on December 6, 2004. At September 30, 2003, we had a balance of $41,667 on the term loan facility and $3.5 million on the working capital line, net of debt discount of
$111,000.



The amount available under the working
capital line of credit as of September 30, 2003 was 65% of our eligible accounts receivable, which approximately equaled our ending loan balance of $3.5 million. This percentage may be adjusted up or down based on a quarterly analysis by the bank
and was recently adjusted to 75%. Eligible accounts receivable are those accounts receivable that the bank determines in its good faith business judgment to include in the borrowing base. Certain accounts, such as accounts that are over 90 days past
due, unbilled receivables and foreign or government accounts, are not currently eligible. Although we may take steps to include foreign and government accounts in our borrowing base, there is additional cost involved and we have not deemed it
necessary to do so to date. As a result of this limitation on eligible accounts, the entire $10 million is not currently available to us under the line of credit and the entire $10 million may not become available in the future. Moreover,
because the amount available for borrowing under our agreement is based on our eligible accounts receivable, we may from time to time become over-advanced under the line of credit if our eligible accounts receivable decrease, either because they
have been collected but not applied against the existing advances or because they have become ineligible under the terms of the agreement. In such a case we may be required to immediately repay a portion of the amount borrowed sufficient to bring
the total amount owed to no more than the total availability under the loan facility.



Click2learn had a note payable of approximately $630,000 that was paid off during the three month period ended September 30, 2003.



If we terminate our planned merger with Docent under certain specified conditions we could be required to pay Docent a $2.5
million termination fee. Such an event would negatively impact our liquidity. If Docent terminates our planned merger under certain specified conditions they could be required to pay Click2learn a $2.5 million termination fee. This fee would cover
our anticipated expenses related to the proposed transaction and therefore would not significantly improve our liquidity.



Our long-term liquidity will be affected by numerous factors, including whether or not the announced merger with Docent closes as anticipated, demand for
our Aspen platform, the level and timing of revenue, the collection of our receivables, the availability of our line of credit, the extent to which we raise additional funds from investors, the timing and extent to which we invest in new technology,
the expenses of sales and marketing and new product development, the extent to which competitors are successful in developing their own products and services and increasing their own market share, acquisitions of businesses or technologies and other
factors. To the extent that our existing capital resources are insufficient to fund our activities, we may need to raise additional funds. Such additional funding, if needed, may not be available on attractive terms or at all. If adequate funds are
not available on acceptable terms, we may be required to make further expense reductions, which could significantly restrict our operations and limit our ability to enhance our products, fund expansion, respond to competitive pressures or take
advantage of business opportunities.



Our contractual
commitments at September 30, 2003 are substantially similar to those at December 31, 2002 disclosed in our annual report on Form 10-K.



22



---

##### Table of Contents

Factors That May Affect Future Results of Operations



Our business and results of operations are likely to be affected by our announced merger
with Docent, Inc.



The announcement of the proposed
transaction with Docent could have an adverse effect on our revenue in the near-term if customers delay, defer or cancel purchases pending consummation of the planned transaction due to potential uncertainty about the direction of the combined
companys product offerings and its support and service of existing products. To the extent that our announcement of the transaction creates uncertainty among customers such that one or more large customers, or a significant group of small
customers, delays purchase decisions pending consummation of the planned transaction, our results of operations could be negatively affected. Decreased revenue could have a variety of adverse effects, including negative consequences to our
relationships with, and ongoing obligations to, customers, suppliers, business partners, and others with whom we have business relationships. In addition, our quarterly operating results and revenue could be substantially below the expectations of
market analysts, which could cause a decline in our stock price.



Our
quarterly operating results are uncertain and may fluctuate significantly, which could negatively affect the value of your investment.



Our operating results are difficult to predict accurately and have varied significantly from quarter to quarter and are likely to continue to fluctuate as
a result of a variety of factors, many of which we cannot control. Factors that may adversely affect our quarterly operating results include:



| |  | the size and timing of product orders and the timing and execution of professional services engagements;
| | - | --------------------------------------------------------------------------------------------------------



| |  | the mix of revenue from products and services;
| | - | ----------------------------------------------



| |  | the mix of products sold;
| | - | -------------------------



| |  | the ability to meet client project milestones;
| | - | ----------------------------------------------



| |  | the market acceptance of our products and services;
| | - | ---------------------------------------------------



| |  | the ability to develop and market new or enhanced products and services in a timely manner and the market acceptance of these products and services;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the timing of revenue and expense recognition; and
| | - | --------------------------------------------------



| |  | recognition of impairment of existing assets.
| | - | ---------------------------------------------



Our future revenue is difficult to predict and we may not be able to adjust spending in response to revenue shortfalls. Our limited operating history with
our current enterprise learning solutions and the rapidly evolving nature of the enterprise learning market make prediction of future revenue and expenses difficult. Expense levels are based, in part, on expectations as to future revenue and largely
are fixed in the short term. If we are unable to predict future revenue accurately, we may be unable to adjust spending in a timely manner to compensate for any unexpected revenue shortfall.



Our business may not generate the cash needed to finance our operations, and for that and
other reasons we may need additional financing in the future, which we may be unable to obtain.



If our business does not generate the cash needed to finance our operations, we may need to obtain additional financing or take steps to restrict our
operations in order to conserve existing cash. In addition, poor financial results or unanticipated expenses could give rise to additional financing requirements. We may be unable to obtain financing on terms favorable to us, or at all. If we need
to obtain financing and adequate funds are not available or are not available on acceptable terms, we may be required to make further expense reductions, which could significantly restrict our operations and limit our ability to enhance our
products, fund expansion, respond to competitive pressures or take advantage of business opportunities.



23



---

##### Table of Contents

We may suffer additional adverse consequences if the proposed transaction with Docent is not completed.



If the planned merger with Docent is not completed, we
could suffer a number of consequences that may adversely affect our business, results of operations and stock price, including the following:



| |  | we would not realize the benefits we expect from becoming part of a combined company with Docent, including the potentially enhanced financial and competitive position;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | activities relating to the merger and related uncertainties may divert our managements attention from our day-to-day business and cause disruptions among our employees and to
our relationships with customers and business partners, thus detracting from our ability to increase revenue and minimize costs and possibly leading to a loss of revenue and market position that we may not be able to regain if the transaction does
not occur;
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the market price of our common stock could decline following an announcement that the merger has been abandoned, to the extent that the current market price reflects a market
assumption that the merger will be completed;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we could be required to pay Docent a $2.5 million termination fee if the merger agreement is terminated under certain specified conditions;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------



| |  | we would remain liable for certain costs related to the transaction, such as legal, accounting, financial advisor and financial printing fees;
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------



| |  | we may not be able to continue our present level of operations and therefore may have to scale back our present level of business and consider additional reductions in force; and
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | we may not be able to take advantage of alternative business opportunities or effectively respond to competitive pressures.
| | - | ---------------------------------------------------------------------------------------------------------------------------



Sales cycles are lengthy, requiring considerable additional investment with no assurance
of generating revenue from our efforts.



The period between
our initial contact with a potential customer and that customers purchase of our products and services is lengthy and may extend over several fiscal quarters. To sell our products and services successfully, we company generally must educate
our potential customers regarding the use and benefits of our products and services, which can require significant time, capital and other resources. The delay or failure to complete sales in a particular quarter could reduce our revenue in that
quarter, as well as subsequent quarters over which revenue for the sale would likely be recognized. If the sales cycle unexpectedly lengthens in general or for one or more large orders, it would negatively affect the timing of our revenue and our
revenue growth would be harmed.



Although we must expend and
allocate resources prior to completing a sales transaction, we may never generate any revenue from these activities. In addition, many of our potential customers are large enterprises that generally take longer than smaller organizations to make
significant business decisions.



Moreover, our revenue will be
subject to fluctuation as a result of general economic conditions and overall spending in the technology and enterprise software sectors. A weakening economy could result in organizations further delaying, canceling, or reducing capital expenditures
generally and spending on enterprise software applications in particular. A significant portion of our revenue is derived from the sale of products and services to large companies or government agencies, which historically have reduced their
expenditures for enterprise software applications during economic downturns.



Any failure to meet investor expectations for a given quarter as a result of delayed customer decisions, reduced order sizes or failed sales efforts would likely cause the price of our common stock to decline.



24



---

##### Table of Contents

We have a history of losses and may have continued losses in the future.



We incurred a net loss of approximately $3.1 million for the nine months
ended September 30, 2003. As of September 30, 2003, our accumulated deficit was $233.1 million. Although our business generated positive cash flow from operations over the nine-month period ending September 30, 2003, we have not yet achieved
profitability and may not do so. Even if we do achieve profitability, we may be unable to sustain or increase profitability on a quarterly or annual basis.



We have a limited operating history with the Aspen suite, which makes it difficult to predict our future performance.



The primary focus of our business is and throughout 2003 will continue to be
the Aspen suite. We released the first version of the Aspen suite in September 2001 and released the first major upgrade in September 2002. Accordingly, we have a limited operating history on which to evaluate our current business and future
prospects. Our limited operating history with the Aspen suite makes it difficult to predict our future performance and may not provide investors with a meaningful basis for evaluating an investment in our common stock.



The enterprise learning software market may not grow to a sufficient size or at a
sufficient rate to sustain our business.



The enterprise
learning software market may not grow to a sufficient size or at a sufficient rate for our business to succeed. Corporate training and education historically have been conducted primarily through classroom instruction. Although technology-based
training applications have been available for many years, they currently account for only a small portion of the overall corporate learning market. Accordingly, our success will depend on the extent to which companies implement enterprise learning
software solutions for the design, development, delivery and management of their corporate learning needs.



Many companies that have already invested substantial resources in traditional training methods may be reluctant to adopt a new strategy that may limit or
compete with their existing investments. Even if companies implement enterprise learning software solutions, they may still choose to develop such solutions internally. If the use of enterprise learning software does not become widespread or if
companies choose to develop such software internally rather than acquiring it from third parties, then our enterprise learning software may not be commercially successful.



We face risks encountered in rapidly evolving markets and may be unsuccessful in addressing these risks.



We face risks frequently encountered in rapidly evolving markets. Specific
risks we face relate to the demand for and market acceptance of our enterprise learning solutions. We may fail to adequately address these risks, and therefore our business may suffer. To address these risks, we must:



| |  | effectively market our enterprise learning software to new and existing customers;
| | - | ----------------------------------------------------------------------------------



| |  | continue to enhance the technology upon which our enterprise learning software is based;
| | - | ----------------------------------------------------------------------------------------



| |  | successfully implement our enterprise learning software for our customers and generate continuing revenue from those customers; and
| | - | -----------------------------------------------------------------------------------------------------------------------------------



| |  | address and establish new technologies and technology standards.
| | - | ----------------------------------------------------------------



We face intense competition from other enterprise learning software providers and may be unable to compete successfully.



The enterprise learning software market is highly fragmented and competitive,
with no single firm accounting for a dominant market share. Our competitors vary in size, scope and the breadth of products and services offered. We face competition from:



| |  | other developers of enterprise learning systems;
| | - | ------------------------------------------------



25



---

##### Table of Contents

| |  | providers of other enterprise software solutions;
| | - | -------------------------------------------------



| |  | large professional consulting firms and in-house IT departments; and
| | - | --------------------------------------------------------------------



| |  | developers of web authoring tools.
| | - | ----------------------------------



There are relatively low barriers to entry in the enterprise learning market and new competitors may enter this market in the future. Increased
competition may result in price reductions, reduced gross margins and loss of market share. We may not be able to contend effectively with such increased competition. In particular, vendors of other enterprise software applications such as
enterprise resource planning, human resource management or customer relationship management have begun to offer learning delivery and management functionality to extend their current product lines within their existing customer base. Although these
offerings may not offer the same functionality as our Aspen suite, bundling these offerings with the remainder of their solutions could diminish our ability to sell our products and services to their customers and announcements by these companies of
future products could delay purchasing decisions by their customers and our prospects, either of which could adversely affect our business.



Certain of our existing and potential competitors have longer operating histories and significantly greater financial, technical, marketing and other
resources and therefore may be able to respond more quickly to new or changing opportunities, technologies, standards and customer requirements or to compete more aggressively on pricing. Price competition would likely result in reduced gross
margins and may prevent the Aspen suite from yielding results sufficient for our business to succeed.



Strategic relationships are important in expanding the distribution reach of companies in the enterprise learning market. If our competitors were to
establish strategic relationships to resell or distribute their products through their strategic partners, our ability to market and sell products and services successfully may be substantially diminished. In addition, the existence or announcement
of strategic relationships involving our competitors could adversely affect our ability to attract and retain customers.



International operations may impose substantial burdens on our resources, divert managements attention or otherwise harm our business.



We rely on independent partners in foreign countries to help conduct our
international operations and sales and marketing efforts. Our success in international markets consequently will depend to a large degree on the success of these independent partners, over which we have little control. If they are unwilling or
unable to dedicate sufficient resources to our relationships, our international operations will suffer.



We rely on our operations in Hyderabad, India to enable us to complete customer implementation projects and new releases of the Aspen suite on time and
within our established budgets. Should our operations in Hyderabad be disrupted for any significant period of time, it could prevent us from completing customer implementations or new releases of the Aspen suite in a timely manner, which could cause
our business to suffer.



Our efforts in Hyderabad and elsewhere
abroad are subject to a number of risks inherent in international operations, including:



| |  | diversion of management attention;
| | - | ----------------------------------



| |  | difficulties and costs of staffing and managing foreign offices;
| | - | ----------------------------------------------------------------



| |  | different learning styles and cultures;
| | - | ---------------------------------------



| |  | numerous and potentially conflicting regulatory requirements;
| | - | -------------------------------------------------------------



| |  | export controls, import tariffs and other barriers to trade;
| | - | ------------------------------------------------------------



| |  | changes in laws or governmental policies;
| | - | -----------------------------------------



26



---

##### Table of Contents

| |  | reduced protection of intellectual property rights;
| | - | ---------------------------------------------------



| |  | regional political and economic instability; and
| | - | ------------------------------------------------



| |  | fluctuations in currency exchange rates.
| | - | ----------------------------------------



Our debt covenants may significantly restrict our operations.



We are subject to numerous covenants in our agreement with Silicon Valley Bank that impose financial and operating restrictions on our business if we wish
to maintain availability of the credit facility. These restrictions may affect our ability to operate our business, may limit our ability to take advantage of potential business opportunities as they arise, and may adversely affect the conduct of
our current business. These covenants place restrictions on our ability to, among other things:



| |  | incur debt with parties other than Silicon Valley Bank;
| | - | -------------------------------------------------------



| |  | pay dividends, redeem or repurchase our stock or make other distributions;
| | - | --------------------------------------------------------------------------



| |  | make acquisitions or investments;
| | - | ---------------------------------



| |  | engage in new or different businesses;
| | - | --------------------------------------



| |  | change our capital structure;
| | - | -----------------------------



| |  | use assets as security in other transactions;
| | - | ---------------------------------------------



| |  | enter into transactions with affiliates or outside the ordinary course of business;
| | - | -----------------------------------------------------------------------------------



| |  | merge or consolidate with others or acquire assets outside the ordinary course of business;
| | - | -------------------------------------------------------------------------------------------



| |  | dispose of assets or use asset sale proceeds;
| | - | ---------------------------------------------



| |  | create liens on our assets; and
| | - | -------------------------------



| |  | extend or guaranty credit.
| | - | --------------------------



In addition, the terms of our indebtedness require that we meet certain financial covenants related to maximum net losses and minimum tangible net worth.
The covenants governing our existing indebtedness restrict our operations and those of our subsidiaries, and these limitations could impair our ability to meet such financial covenants. In addition, our ability to meet these financial covenants and
to comply with other provisions governing our indebtedness may be affected by changes in economic or business conditions or other events beyond our control. Moreover, failure to comply with our debt-related obligations could result in an event of
default that, if not cured or waived, could result in an acceleration of our indebtedness. We are currently in compliance with these covenants, but we cannot assure you that we will not violate these covenants in the future. In the past, we have on
occasion violated certain of the covenants under our loan agreements with Silicon Valley Bank and the bank has waived those violations without cost to us. However, we cannot assure you that the bank will waive any future violations at no cost to us,
or at all.



Moreover, because the amount available for
borrowing under our agreement is based on our eligible accounts receivable, we may from time to time become over-advanced under the line of credit if our eligible accounts receivable decrease, either because they have been collected but not applied
against the existing obligations or because they have become ineligible under the terms of the agreement. In such a case we may be required to immediately repay a portion of the amount borrowed sufficient to bring the total amount owed to no more
than the total availability under the loan facility.



The loss of the
services of our senior executives and key personnel would likely cause our business to suffer.



Our success depends to a significant degree on the performance of the senior management team and other key employees. The loss of any of these individuals
could harm our business. We do not have employment



27



---

##### Table of Contents

agreements with several of our executives or with any other key employees, and we do not maintain key person life insurance for any officers or key
employees.



Our success also depends on our ability to attract,
integrate, motivate and retain highly skilled technical, sales and marketing and professional services personnel. Competition for qualified personnel in the software industry is intense. To the extent we are unable to attract and retain skilled
personnel our business will suffer.



Our Aspen suite is a new product and
may contain defects or otherwise perform improperly.



Our
Aspen suite was initially released in September 2001, and the first major version upgrade was released in September 2002. We anticipate continuing to add new features, functionality and components. Complex enterprise software products frequently
contain errors or failures, especially when first introduced or when new versions are released. Because the Aspen products are complex software packages with new features and functionality being added and new versions being released on a regular
basis, there is a greater likelihood that they may contain such errors. In addition, since the Aspen suite is targeted at enterprise customers with large numbers of users, customers and potential customers may have a greater sensitivity to product
defects or product integration than the market for software products generally. To date we have experienced errors in the Aspen platform, in particular when new versions or functionality is first released, although such errors have not had a
material impact on our business and generally have been corrected shortly after discovery. Although we have not experienced this to date, serious product errors could result in loss of revenue or delay in market acceptance, diversion of development
resources, damage to our reputation, or increased service and warranty costs.



We may not be able to adapt to rapidly changing technology and evolving industry standards.



The enterprise learning software market is characterized by rapidly changing technologies, frequent new product and service introductions, short
development cycles and evolving industry standards. The introduction of new products and services embodying new technologies and the emergence of new industry standards may render our products and services obsolete. Our success depends on our
ability to adapt to a rapidly changing landscape and to offer new products and services to address our customers changing demands. We may experience difficulties that delay or prevent the successful design, development, introduction or
marketing of our products and services. To the extent we in fact experience such delays, we may experience difficulty in attracting new customers and may lose existing customers.



If we are unable to build the Click2learn and Aspen brands, we may be unable to grow our business.



We believe that establishing and maintaining the Click2learn and Aspen brands
will be critical to the success of our enterprise learning strategy and that the importance of brand recognition will increase as the market for enterprise learning software products grows. If our brand building strategy is unsuccessful, our
business could be materially harmed.



We face the risk of liability for
failures to meet unique customer requirements, and the risk of cost overruns on fixed-price projects.



The failure or inability to meet a customers unique expectations or requirements in the performance of services could impair our reputation or
result in a claim for damages, regardless of our responsibility for the failure. Although generally we attempt to limit contractually our liability for damages arising from product defects and other mistakes in rendering professional services, these
contractual protections are not always obtained and may not be enforced or otherwise may not protect us from liability. Our insurance may not be sufficient to cover these claims. In addition, most of our professional services projects are performed
on a fixed-price basis rather than on a time and materials basis. If we do not complete fixed-price engagements within budget, on time and to clients satisfaction, we bear the risk of cost overruns.



28



---

##### Table of Contents

Security and privacy breaches could subject us to litigation and liability.



We host certain of our customers enterprise learning software
implementations at our data center and provide access to that software using the Internet. The Internet is a public network and data is sent over this network from many sources. Although we take reasonable steps in accordance with current industry
practices to ensure the security of our hosting systems and customer data, computer viruses could be introduced into our systems or those of our customers, which could disrupt the operation of our hosting systems or make them inaccessible to users.
We depend on Internet service providers and telecommunications companies and the efficient operation of their computer networks and other computer equipment to enable customers to access and use hosted software implementations. Each of these has
experienced significant outages in the past and could experience outages, delays and other difficulties due to system failures unrelated to our systems, which could cause our customers to believe we were at fault and withhold payments due to us.



We could become subject to litigation and liability if third
parties penetrate security for our hosting systems or otherwise misappropriate our users confidential information or if customers are unable to access and use hosted software implementations. Advances in computer capabilities, new discoveries
in the field of cryptography or other technological events or developments could result in compromises or breaches of our security systems. Anyone who circumvents our security measures could misappropriate proprietary information or cause
interruptions in our services or operations. We may be required to expend significant capital and other resources to protect against the threat of security breaches or service interruptions or to alleviate problems caused by breaches or service
interruptions.



Acquisitions or investments may drain capital and equity
resources, divert managements attention or otherwise harm our business.



In the future we may acquire or make investments in other businesses, products or technologies. Such acquisitions or investments may require that we pay significant cash, issue stock or incur substantial debt. In
addition, such acquisitions or investments may require significant managerial attention, which may be diverted from our other operations. These capital, equity and managerial commitments may impair the operation of our business. Furthermore,
acquired businesses may not be effectively integrated, may be unable to maintain key pre-acquisition business relationships, may contribute to increased fixed costs and may expose us to unanticipated liabilities.



Our intellectual property may become subject to legal challenges, unauthorized use or
infringement, any of which could diminish the value of our products and services.



Our success depends in large part on our proprietary technology. We rely on a combination of copyrights, trademarks, trade secret laws, restrictions on disclosure and other methods to protect our proprietary
technology. We do not have patents for any of the technology underlying our Aspen platform. If we fail to successfully enforce our intellectual property rights, the value of these rights, and consequently the value of our products and services to
our customers, could diminish substantially. It may be possible for third parties to copy or otherwise obtain and use our intellectual property or trade secrets without our authorization, and it may be possible for third parties to independently
develop substantially equivalent intellectual property.



Litigation may be necessary in the future to enforce our intellectual property rights, to protect trade secrets or to determine the validity and scope of the proprietary rights of others. From time to time we have received, and may in the
future receive, notice of claims of infringement of other parties proprietary rights. Such claims could result in costly litigation and could divert management and technical resources. They could also delay product shipment or require us to
develop non-infringing technology or enter into royalty or licensing agreements, which agreements may not be available on reasonable terms, or at all.



29



---

##### Table of Contents

Our products include third-party technology, the loss of which could materially harm our business.



We use some licensed third-party technology components in our products.
Future licenses to this technology may not be available to us on commercially reasonable terms, or at all. The loss of or inability to obtain or maintain any of these technology licenses could result in delays in the introduction of new products or
could force us to discontinue offering portions of our enterprise learning solutions until equivalent technology, if available, is identified, licensed and integrated. Furthermore, we may become subject to legal claims related to licensed technology
based on product liability, infringement of intellectual property or other legal theories.



Our stock price has been and may continue to be volatile.



The trading price of our common stock has been and is likely to continue to be highly volatile. For example, during the 52-week period ended September 30,
2003, the price of our common stock ranged from $0.52 to $2.41 per share. Our stock price is subject to continued fluctuations in response to a number of factors, including:



| |  | actual or anticipated variations in quarterly operating results;
| | - | ----------------------------------------------------------------



| |  | changes in financial estimates or recommendations by securities analysts;
| | - | -------------------------------------------------------------------------



| |  | conditions or trends in the learning and enterprise software markets;
| | - | ---------------------------------------------------------------------



| |  | announcements by us or our competitors of significant customer wins, technological innovations, new products or services;
| | - | -------------------------------------------------------------------------------------------------------------------------



| |  | announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
| | - | ----------------------------------------------------------------------------------------------------------------------------------



| |  | additions or departures of key personnel;
| | - | -----------------------------------------



| |  | sales of our common stock; and
| | - | ------------------------------



| |  | general market conditions.
| | - | --------------------------



The stock market in general, and the market for enterprise software and technology companies in particular, recently has experienced extreme price and
volume fluctuations that have been unrelated or disproportionate to the operating performance of many of the affected companies. These broad market and industry factors may depress our stock price, regardless of our operating performance.



In the past, companies that have experienced volatility in the
market price of their stock have been subject to securities class action litigation. We may be the targets of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our managements
attention, which could seriously harm our business.



Item 3. Quantitative and Qualitative Disclosures about Market Risk



Market Rate Risk.We are exposed to market risk related to changes in interest rates and foreign currency exchange rates. We do not use derivative
financial instruments for speculative or trading purposes.



Interest Rate Risk.We hold our assets primarily in cash and cash equivalents, such as short-term marketable debt securities, money market funds and other cash equivalents. We minimize risk by investing in financial instruments with
maturity of three months or less. As a result, if market interest rates were to increase immediately and uniformly by 10% from levels at December 31, 2002, the fair value of cash and cash equivalents would not change by a material amount.



Foreign Currency Exchange Risk.We have foreign
currency risk as a result of foreign subsidiary activities. For the three and nine months ended September 30, 2003, international revenue from foreign subsidiaries



30



---

##### Table of Contents

accounted for approximately 11% and 9%, respectively, of total revenue. All foreign subsidiaries use the local currency as their functional currency.



Our exposure to foreign exchange rate fluctuations arises in
part from intercompany accounts in which costs incurred in the United States are charged to the foreign subsidiaries. These intercompany accounts are typically denominated in the functional currency of the foreign subsidiary in order to centralize
foreign exchange risk with the parent company in the United States. We are also exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated in U.S. dollars in consolidation. As exchange rates vary,
these results, when translated, may vary from expectations and adversely impact overall expected profitability. The effect of foreign exchange rate fluctuations for the nine months ended September 30, 2003 was not material. Due to the substantial
volatility of currency exchange rates, among other factors, we cannot predict the effect of exchange rate fluctuations on our future operating results.



Item 4. Controls and Procedures



Click2learn maintains a set of disclosure controls and procedures designed to ensure that information required to be disclosed in filings made pursuant to the Securities Exchange Act of 1934 (the Exchange Act) is recorded,
processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms. Our principal executive and financial officers have evaluated our disclosure controls and procedures as of the end
of the period covered by this report and have determined that such disclosure controls and procedures are effective.



No changes were made to our internal control over financial reporting in connection with this evaluation that has materially affected, or is reasonably
like to materially affect, our internal control over financial reporting.



31



---

##### Table of Contents

PART IIOTHER INFORMATION



Item 1. Legal Proceedings



Not
applicable.



Item 2. Changes In Securities and Use of Proceeds



Not applicable.



Item 3. Defaults Upon Senior Securities



Not applicable.



Item 4. Submission of Matters to a Vote of Securities Holders



Not applicable.



Item 5. Other Information



On
October 20, 2003, we announced the execution of an Agreement and Plan of Reorganization, dated as of October 20, 2003 (the Merger Agreement), by and among us, Docent, Hockey Merger Corporation, a Delaware corporation (Newco),
Canuck Acquisition Corporation, a Delaware corporation and a wholly-owned subsidiary of Newco (Click2learn Merger Sub) and Devil Acquisition Corporation, a Delaware corporation and a wholly-owned subsidiary of Newco (Docent Merger
Sub). In the transaction, Click2learn Merger Sub will merge with and into us and each issued and outstanding share of our common stock will be exchanged for 0.4144 shares of Newco common stock (the Click2learn Exchange Ratio),
Docent Merger Sub will merge with and into Docent and each issued and outstanding share of Docent common stock will be exchanged for 0.9525 shares of Newco common stock (the Docent Exchange Ratio). In addition, (i) each outstanding
option and warrant to purchase shares of our common stock will be assumed by Newco and will represent the right to purchase a number of shares of Newco common stock based on the Click2learn Exchange Ratio, and the exercise price per share will be
adjusted accordingly, and (ii) each outstanding option and warrant to purchase Docent common stock will be assumed by Newco and will represent the right to purchase a number of shares of Newco common stock based on the Docent Exchange Ratio, and the
exercise price per share will be adjusted accordingly. The separate corporate existences of Click2learn Merger Sub and Docent Merger Sub will thereupon cease and Docent and us will each continue as wholly owned subsidiaries of Newco.



The consummation of the merger is subject to the approval of our stockholders
and the stockholders of Docent and other customary closing conditions. The merger is intended to be a tax-free reorganization under Section 368 of the Internal Revenue Code of 1986, as amended (the Code) and/or qualify as a tax-free
exchange under Section 351 of the Code, and is expected to be treated as a purchase for financial accounting purposes, in accordance with generally accepted accounting principles generally accepted in the United States of America.



The foregoing description of the Merger Agreement does not purport to be
complete and is qualified in its entirety by the terms and conditions of the Merger Agreement. Copies of the Merger Agreement and other documents related to the transaction are attached as exhibits to the Current Report of Form 8-K we filed with the
Securities and Exchange Commission on October 20, 2003.



32



---

##### Table of Contents

Item 6. Exhibits and Reports on Form 8-K



(a)    Exhibits.



|     |  |                                                                                                                                                                              
|---- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|     | 
|31.1 |  | Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                          
|     | 
|31.2 |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                           
|     | 
|32.1 |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



(b)    Reports on Form 8-K.



A
report on Form 8-K dated July 25, 2003 was filed announcing results of operations for the six months ended June 30, 2003. No financial statements were filed with such report.



33



---

##### Table of Contents

SIGNATURES



Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                  |  |  |  |                                                                                               
|----------------- |  |  |  | ----------------------------------------------------------------------------------------------
|                  |  |  |  | CLICK2LEARN, INC.                                                                             
|                  |  | 
|February 10, 2004 |  |  |  | /s/    JOHN D.
ATHERLY                                                                        
|Date              |  |  |  | John D. Atherly Chief Financial Officer (Duly Authorized Officer and Chief Accounting Officer)



34



---

##### Table of Contents



|            |  |                                                                                                                                                                              
|----------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitList |  |                                                                                                                                                                              
|            | 
|31.1        |  | Certifications of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                          
|            | 
|31.2        |  | Certifications of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                          
|            | 
|32.1        |  | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



35